Monday, January 6, 2014

Bitcoin’s prospects for 2014

Is it a bubble or mania destined for collapse?Or can it beat the odds and become a viable
alternative to the dollar?

That’s what many are wondering about Bitcoin,
the electronic currency which has captured the Internet world’s
imagination. Many observers have
dismissed the e-currency as a passing fad – a flash in the pan destined to
suffer the same fate as break dancing and Beanie Babies. This conclusion is far too simplistic,
however. Due to the complexities of the
new currency the Bitcoin issue demands a deeper analysis.

Looking beyond the rhetoric yields a complex
series of possibilities for Bitcoin’s future.
Let’s start with the most glaring observation, namely the e-currency’s
lofty valuation. At its current level,
Bitcoin is unquestionably too pricey to be considered as a legitimate
alternative to the dollar. The average
American quite simply can’t afford to own Bitcoins, and few are technologically
savvy enough to “mine” them. This is one
major obstacle standing in the way of Bitcoin’s widespread acceptance.

Bitcoin’s ride to stratospheric levels over
the past year is reminiscent of the speculative bubble in the gold market – a
bubble which eventually imploded and scared away multitudes of investors. Runaway speculation caused its price to soar
from $140 to $266 in only four days in April 2013, only to erase most of those
gains a few days later. In October and
November Bitcoin’s value went parabolic, far exceeding the April run-up. This in turn was followed by a sharp decline
in December, followed by another recovery rally (see chart below). Most recently one Bitcoin was quoted as being
worth $842.

It stands to reason that any commodity (or
potential currency) which is subject to excessive speculation and wild
volatility will never succeed in supplanting the dollar as a primary medium of
exchange. There must be relative
stability before buyers and sellers will consider using Bitcoin as an everyday
method of payment. To that end a
collapse in Bitcoin’s value would go a long way in paving the way toward this
end. But a deflation in Bitcoin’s value
alone won’t secure its future as a viable currency. Once Bitcoin has returned to a reasonable
level the speculative element must be largely – if not entirely – eliminated to
ensure that it doesn’t suffer a similar fate in the future.

“For all its weird politics and bad press,”
writes David Wolman in the November issue of Wired, “Bitcoin may just be the most ingenious system ever created
for settling online transactions. Done
right, it could put small ecommerce sites on a level playing field with the
likes of Amazon and Apple.” He urges us
to “commandeer it from the radicals and make it work for the rest of us.”

To circumvent the volatility factor, Wolman
proposes that individuals make it a habit to not hold Bitcoins very long and to
convert them only when making an online transaction. To this end, a San Francisco-based startup
called Coinbase is offering merchants free conversion from Bitcoin into other
currencies. This allows vendors to
accept Bitcoins as payment without having to maintain a cash register full of
them.

Admittedly any proposal based on
self-restraint is likely to fall far short of taming Bitcoin’s extreme volatility. To that end, more extreme measures have been
proposed to decrease volatility and thereby make the e-currency more attractive
as a mainstream medium of exchange. A
group called the Digital Asset Transfer Authority is trying to establish
guidelines for digital currencies such as Bitcoin. E-currency advocates have even suggested the
creation of a central authority to intervene when price fluctuations become too
extreme. Much of Bitcoin’s wild
volatility is undoubtedly due to the fact that it hasn’t yet achieved the
critical mass of widespread acceptance.
Venture capitalist Chris Dixon believes that everyday mainstream use of
Bitcoin would help diminish the price oscillations.

“This currency, like all currencies,”
concludes Wolman, “needs to inspire trust to succeed.” He suggests that centralization is required
to tamp down on Bitcoin’s volatility problem, a suggestion that will no doubt
rankle the die-hard members of the e-currency community.

For owners of Bitcoin concerned with a
possible loss of value, a more practical safeguard is in order. Consider using a basic “stop loss” exit
system based on a retro-fitted moving average.
An example would be the simple 60-day moving average, which has captured
most of Bitcoin’s intermediate-term turning points over the years of its
existence. A 2-day close below the
60-day MA is a good rule of thumb for exiting Bitcoin in anticipation of
additional volatility. As long as Bitcoin
stays above the rising 60-day MA, however, its dominant interim trend should be
considered up.

As I concluded in my Dec. 18 commentary on
Bitcoin, chart pattern analysis suggests there is more upside in the coin’s
future before the bull market in its value comes to an end. The breakout to new highs in Bitcoin’s price
which occurred in November was preceded by six months of base-building. In classical chart analysis this is normally
a good indication of additional upside ahead.

Beyond the near-term outlook is anyone’s
guess. Bitcoin will likely suffer the
same fate as every speculative craze, namely eventual price deflation
culminating in a crash in value. The
suspicion is that this will occur sometime before the end of 2014 while the
long-term Kress cycles are bottoming.
The true test to the new coin’s value will in fact occur after a
cataclysmic setback, for that will determine whether the public is willing to
embrace a currency subject to extreme fluctuations. It will also determine if the public is
willing to risk capital in what may or may not be a safe store of value
relative to the dollar.